The SEC’s focus on the use of Rule 10b5-1 by insiders in rulemakings over the past couple of years has inevitably brought us to the point of asking the question: “Do Rule 10b5-1 plans still make sense for insiders?” It is hard to believe that is a question that we need to ask ourselves, given that Rule 10b5-1 has been so useful for insiders over the first couple decades of its existence.
When Rule 10b5-1 was adopted over twenty years ago, it was part of a larger effort to deal with the fact that the SEC was losing in the courts on insider trading cases. The courts had come out in ways the SEC did not like around the “awareness” standard that the SEC wanted to use when determining if someone was in possession of material nonpublic information at the time they traded. The main purpose of Rule 10b5-1 was to establish an awareness standard going forward that would be applied when bringing insider trading cases. Then, as part of the inevitable horse trading that goes on during the rulemaking process, Rule 10b5-1 trading plans were born. The main concept is that you would have an affirmative defense to an insider trading claim if, at the time when you are not aware of material nonpublic information, you enter into an arrangement to sell securities in the future, even if there are times in the future when you are aware of material nonpublic information. The beauty of Rule 10b5-1 plans as contemplated by the rule was just how straightforward the concept was, in that there were not a lot of conditions imposed by the rule. Essentially, once you have hardwired your trading plan, you would not be tagged with insider trading allegations when those trades happen in accordance with that hardwired plan.
It is important to keep in mind that Rule 10b5-1 was, and still is today, an affirmative defense. It’s not a safe harbor. For Rule 10b5-1 to do you any good, you must be accused of insider trading, and then, you come back with the defense of, “I traded pursuant to a Rule 10b5-1 arrangement. For that reason, I should not be held liable for trading while aware of material nonpublic information.”
The unfortunate dynamic that played out after adoption of Rule 10b5-1 was that academics, SEC staff, journalists and others were very critical of Rule 10b5-1. They thought something was amiss with the way that Rule 10b5-1 plans came to be used by executives, directors and companies in the course of their transactions. In short, for whatever reason, Rule 10b5-1 plans were subject to a smear campaign. While there were certainly some instances of abusive behavior associated with Rule 10b5-1 plans over the years, it was never my experience that they were used in a way that was inherently bad – if anything, Rule 10b5-1 plans proved to be a positive development in that insiders could plan for orderly transactions in company securities without running afoul of the insider trading laws. Companies generally had oversight of the plans through their insider trading policies, and the Rule 10b5-1 plan served as a useful tool for many companies from a governance perspective.
The conditions that the SEC has now added to Rule 10b5-1 plans, including the cooling-off period, the limitation on overlapping plans and the single trade limitation, have undoubtedly complicated the use of Rule 10b5-1 plans. The additional transparency around the use of Rule 10b5-1 plans raises their profile in a company’s SEC filings. There are some types of transactions that we historically relied on Rule 10b5-1 for that do not really work anymore, because of the imposition of the cooling off period and overlapping plan conditions. The SEC is now on record, in both the adopting release and proposing release for the Rule 10b5-1 rule amendments, citing the negative academic studies and press about Rule 10b5-1 plans.
By all accounts, I think Rule 10b5-1 is a survivor, despite all of these headwinds. In my practice, insiders are still utilizing Rule 10b5-1 plans for the same types of planned transactions that they implemented before the amendments. While companies may be less likely to actually mandate the use of Rule 10b5-1 plans, they are also not actively discouraging the use of such plans. Brokers have integrated the rule requirements into their standard Rule 10b5-1 plans, and generally those changes have been accepted. We had the first round of disclosure about the adoption or termination of Rule 10b5-1 plans with the second quarter Form 10-Qs, which did not appear to draw much attention. In situations where an insider is not able to conduct planned transactions through a Rule 10b5-1 plan due to the cooling-off period or the overlapping plan conditions, those transactions can be conducted through the normal pre-clearance and trading window process contemplated by a company’s insider trading policy. In the grand scheme of things, I still think Rule 10b5-1 plans make sense for insiders, when used for the purposes for which the rule was intended.
– Dave Lynn